Would Clothing Sales Tax CutsPay For Themselves?

The Independent Budget Office (IBO) has analyzed a legislative
proposal contained in New York City's recently adopted budget
for fiscal year 1998 and currently under consideration in Albany
that would eliminate sales taxes on apparel items priced under
$500. Clothing purchases in New York City are now subject to an
8.25 percent sales tax, composed of a 4 percent City tax and a
4.25 percent State tax (which includes a 0.25 percent surcharge
for public transit). This analysis measures the potential economic
and secondary tax revenue impacts that would result if all or
part of under-$500 clothing sales taxes were eliminated in New
York City. Our principal findings are:

The direct cost to the City of eliminating its portion of
the sales tax on clothing would be about $300 million per year
over the 1999-2001 period. The cost in 1998 would be a little
over half that amount, since the cut would not go into effect
until almost midway through the fiscal year.

Over time, increased economic activity resulting from the
reduction in the City's sales tax would lead to increases in other
City tax revenues. In 2001, other tax revenues would increase
by up to $17 million, offsetting 5.6 percent of the direct cost
of the sales tax cut. In 2005, when all of these secondary tax
revenue impacts are fully phased in, the revenue increase would
be $24 million, offsetting 6.7 percent of the direct cost.

If the State also eliminates its portion of the clothing sales
tax, the combined economic impact of both the State and City tax
cuts would increase secondary City tax revenues by up to $35 million
in 2001, offsetting 11.6 percent of the direct cost of the City
tax cut, and $49 million in 2005, offsetting almost 14 percent
of the direct City cost.

If the City's move to eliminate its clothing sales tax was
not mirrored by other New York localities, the secondary revenue
offsets from the City tax cut would be higher. The additional
secondary revenues would come from sales shifted from Long Island
and the northern metropolitan New York counties.

The fixed $500 cutoff for the sales tax exemption would distort
apparel prices and cause difficulties for retailers over time.
These problems could be mitigated by adjusting the exemption cutoff
for inflation and taxing just the portion of the sale above the
cutoff.

Overview

Retail clothing sales in New York City are now subject to a 4
percent City sales tax, a 4 percent State sales tax, and a 0.25
percent Metropolitan Commuter Transportation District (MCTD) sales
tax. The centerpiece of the City's 1998 tax program is a proposal
to eliminate (effective December 1997) all sales taxes on apparel
items priced under $500. Under the proposal, New York State would
enact legislation that would permit localities to eliminate their
sales taxes on items priced under $500, and the State would drop
its own sales tax on such items as well.

There are two main arguments offered in favor of this proposal.
First, it would provide especially strong tax relief to lower-income
households, who spend a greater share of their incomes on clothing;
this would make the overall sales tax burden less regressive.
Second, the clothing exemption would increase New York's retail
competitiveness, especially with respect to New Jersey, which
already exempts clothing from its sales tax. This would give a
boost to the City's entire economy. It has been suggested that
this economic impact may be very large, leading to overall increases
in City tax revenues large enough to offset a substantial portion
of the direct costs of the exemption.

To date, there has been little quantitative analysis of these
feedback effects. In this fiscal brief, IBO provides both a reestimate
of the direct cost of the City clothing tax exemption and an estimate
of the secondary economic impacts and offsetting revenue gains
that might reasonably be expected to result from the proposed
tax cut.

The major finding of this fiscal brief is that the proposed clothing
sales tax cut would increase New York City economic activity,
but not nearly enough to have the tax cut pay for itself. Secondary
City tax revenue increases attributable to the impact of both
City and State sales tax reductions would offset no more than
14 percent of the direct City cost of the tax cut.

The first section of the fiscal brief presents IBO's reestimate
of the direct City cost of the proposed reduction in retail sales
taxes. The next several sections are based on the assumption that
all under-$500 clothing sales taxes are eliminated statewide.
The effect of the City sales tax cut on sales, output, and secondary
City tax revenues is examined first, followed by the effect of
the State sales tax cut on City tax revenues. The next
section covers the effects of City and State sales tax cuts on
State tax revenues. The fiscal brief also examines alternative
scenarios, including one in which New York City eliminates its
under-$500 clothing sales tax but other New York localities do
not. The brief concludes with a summary of IBO's major findings
and raises important issues for further consideration.

Direct Cost Estimate

IBO's direct cost projection is based on product sale data provided
by the U.S. Bureau of the Census and New York City Department
of Finance's estimate 91 percent of clothing sales receipts are
from items costing under $500. Adjustments are made to account
for clothing sales that are currently untaxed (such as sales of
items delivered out of the City) and for anticipated marketing
responses to the new tax exemption (repackaging more expensive
ensemble items to take maximum advantage of the exemption).

Our projection also takes into account difficulties that merchants
would have in raising prices when such increases would push items
over the exemption threshold. Consumer resistance would come from
the very high marginal sales tax rates for items priced
at or slightly over $500. (At the extreme, a price change from
$499 to $500 would incur a sales tax change from $0 to $41.25-a
marginal tax rate of 4125 percent!) As a result, the share of
sales going to items priced under $500 is projected to remain
roughly constant over the first few years following implementation
of the exemption, instead of declining due to inflation.

Given these data and assumptions, IBO projects that under-$500
taxable apparel sales in New York City will be $6.9 billion in
1998, rising to a little under $7.6 billion in 2001. Based on
this, IBO forecasts that the proposed City sales tax exemption
for clothing under $500 would directly reduce New York City sales
tax revenues by $161 million in 1998 and $285 million, $294 million,
and $303 million over the following three years. IBO's direct
cost projections are slightly higher than the estimates contained
in the 1998 adopted budget and financial plan.

Although growing price distortions at the $500 exemption threshold
would ultimately force retailers to make price adjustments lowering
the exempt share of total clothing sales, these adjustments would
not remove the price distortions around the exemption cutoff.
Indexing the exemption cutoff for inflation would mitigate some,
but not all, the problems associated with the exemption cap. One
alternative would be to impose sales taxes on just the additional
sales value of items priced over some inflation-adjusted threshold.
(For example $100 of a $600 item would be taxed, $150 of a $650
item, and so on.) By taxing just the additional sales, the marginal
rate spike problem would be avoided and price distortions would
be reduced.

Secondary Impacts: An Overview

The rest of this fiscal brief analyzes the secondary impacts of
the proposed clothing sales tax cuts, first on sales, then on
economic output, and then on taxable transactions, incomes, and
wealth. The analysis holds the level of government outlays (and
the economic impact of those outlays) constant while the level
of taxes (and the economic impact of taxes) changes.

The immediate effect of the sales tax cut would be to lower the
after-tax price of under-$500 apparel purchased in New York City.
This would impact consumer expenditures in three ways. First,
it would enable consumers to buy more for their money-in effect,
increasing the real income of those consumers. This income
effect would raise overall sales of consumer goods and services.
(That is, sales would be higher in New York City and at least
as high as before in the rest of the metropolitan region.)

Second, the clothing tax cut would make under-$500 apparel a better
buy relative to other goods and services sold in the City. This
substitution effect could shift some consumer spending
away from other goods and services to apparel, but it would not
substantially change the overall volume of sales in New York City
or in the metropolitan region.

Finally, the sales tax cut would also make apparel sold in the
City less expensive relative to apparel sold elsewhere in the
region-except, of course, in other localities that are also cutting
clothing taxes. This additional substitution effect again would
again hardly change the overall level of sales in the metropolitan
region, but it would increase sales in New York City by giving
the City a larger share of regional apparel sales.

If there were no substitution effects, the income effect produced
by the clothing sales tax cut would raise consumer expenditures
in New York City by about as much as the City is losing in sales
tax revenues, and these new expenditures would generally follow
current patterns of consumer spending by City residents. However,
because of the first substitution effect, a roughly equivalent
amount of spending is likely to be shifted within the City from
other goods and services to under-$500 apparel. The net result
of this is that there would be little new spending on anything
other than apparel. Then with the added impact of the second substitution
effect, the total increase in retail apparel sales in New York
City would be larger than the direct cost of the clothing tax
cut.

Retail markets are largely local or regional markets. This sets
an outside limit-ultimately given by the total income in a region-to
the sales increases or shifts that can follow a local sales tax
cut. The critical issue in terms of the overall economic impact
of the proposed clothing sales tax cut is how large the second
substitution effect would be, that is, how much apparel sales
would be shifted from the rest of the metropolitan region to New
York City after the cut.

The potential for a significant intraregional shift is suggested
by the present clothing sales "gap" between New York
City and New Jersey. In 1992, northeast New Jersey accounted for
33.8 percent of total resident personal income in the New York
City metropolitan area and 36.6 percent of total apparel sales,
while New York City itself had 41.6 percent of the region's resident
personal income and only 38.4 percent of the apparel sales.

New Jersey's disproportionately large share of the region's total
clothing sales is often cited as evidence of the competitive cost
advantage provided by its own clothing sales tax exemption. Ifthe sales tax differential is the entire reason why
the City is losing apparel market share to New Jersey, then fully
eliminating the City's 8.25 percent sales tax would get the City
a total apparel sales increase of 11.85 percent-that is, 8.25
percent in new apparel sales from the income effect (modified
by the first substitution effect), plus another 3.6 percent in
sales shifted into the City by the second substitution effect.
In short, every $1.00 cut in the sales tax would raise under-$500
apparel sales by $1.43. (11.85 percent 8.25 percent 1.43.) With
the additional sales shifted from New Jersey, the latter's sales
tax advantage and disproportionate apparel sales share would both
be eliminated.

There are several reasons why this may overestimate the potential
for increasing New York City apparel sales. For one, insofar as
the City's clothing sales gap reflects differences between after-tax
retail apparel costs in New York City and New Jersey, the sales
tax differential is not the only source of the City's disadvantage.
Retail labor costs are also substantially higher in the City.
In 1992, total retail labor costs accounted for approximately
15.9 percent of apparel retail sales revenues in New York City,
compared with 13.4 percent of apparel retail sales revenues in
New Jersey. New York City retailers also have higher real estate
costs (including commercial property taxes) and higher utility
costs (including utility taxes).

Perhaps even more telling, New York City suffers a comparable
clothing retail sales "gap" versus Long Island, which
has 15.9 percent of the region's personal income but accounts
for 17.5 percent of clothing sales. Yet Long Island's 8.5 percent
sales tax rate is actually 0.25 percentage points higher
than the City's. (Again, retail labor costs on the Island are-as
in New Jersey-only 13.4 percent of apparel sales revenues, substantially
lower than in the City.)

Beyond the matter of differences in nontax retail costs, New York
City's retail sales gaps (in apparel and elsewhere) also highlight
the importance of store competition around things like selection
and convenience in determining market share. All this makes it
extremely unlikely that the sales tax cut alone would "level
the playing field" for New York City apparel retailers. While
this does not absolutely rule out 11.85 percent growth in apparel
sales following elimination of the clothing sales tax, it makes
the prospect of any increase larger than that unlikely.

City Tax Cut Impact on Sales and Output

The next two sections consider only the potential secondary impacts
of the City's portion of the sales tax cut. It is assumed
here that under-$500 clothing taxes are eliminated in other New
York localities at the same time they are eliminated in the City.
This means that after-tax apparel prices in the City would fall
relative to prices in New Jersey (and in Connecticut), but not
relative to prices on Long Island or elsewhere in New York. This
assumption is relaxed in the section on alternative scenarios.

On the assumption that New York City apparel sales would rise
11.85 percent when all clothing taxes are eliminated, cutting
the 4 percent City sales tax itself would yield a 5.75 percent
sales increase (4 percent x 1.43 5.75 percent). Lines 1-3 in Figure
1 show the results of assuming a sales impact of that magnitude.
For 1998, 5.75 percent growth in under-$500 apparel sales would
work out to a $231 million sales increase, including $161 million
generated by the income effect and $70 million shifted to the
City by the substitution effect.

Figure 1.
Proposed Sales Tax Exemption for Clothing Purchases Under
$500: Impact of City's Share of Tax Cut on Sales and Output in New
York Citya (In millions of dollars)

a) Assumes government outlays held harmless as taxes are cut. Does not include additional impacts of concurrent State sales tax cut on New York City sales and output.
b) Excludes indirect business tax prtion of retail sector output.
c) New output and new producer value from the income effect only: the substitution effect shifts existing output.

In 1999, the first full year of the tax cut, sales would rise
$409 million, including $124 million shifted mainly from New Jersey.
By 2001, the increase in sales associated with the City clothing
sales tax cut would be $434 million, including $132 million recaptured
from New Jersey.

Output multipliers for New York City are provided by the Regional
Input-Output Modeling System (known as RIMS II) constructed by
the U.S. Department of Commerce's Bureau of Economic Analysis.
These multipliers measure the additional impacts on City economic
output of an initial change in output in a given sector. In the
case of an initial change in retail sales, however, an output
multiplier should not be applied to the entire increase in sales
revenue. Rather, it must be applied specifically to the portion
of the increase in sales revenue representing locally produced
output or value added. This includes the value of the local retail,
wholesale, and transportation inputs used in the new sales of
apparel merchandise in the City, plus the value of the merchandise
itself if it has been newly manufactured in New York City.

Altogether, local value added makes up about 61 percent of current
apparel sales revenue in New York City, and it would make up the
same share of new apparel sales generated by the income effect.
The retail margin (the difference between what retailers pay for
merchandise purchased for resale and what they receive upon final
sale) is almost 42 percent of apparel sales and wholesale and
transportation costs are about 7 percent. Products manufactured
by the City's own clothing industry comprise another 12 percent.
The non-local value added remainder comes from imports of apparel
merchandise produced elsewhere. The portion of increased local
retail sales revenue that pays for imports does not add to the
gross product of New York City but rather to the gross products
of the exporting regions.

In the case of apparel sales shifted into the City by the second
substitution effect, no new manufacture of merchandise (either
local or nonlocal) is actually involved; the additional sales
of locally manufactured goods in New York City is merely the counterpart
of reduced sales of those same goods elsewhere in the region.
Therefore the local value added share of these shifted sales is
just the 49 percent of the sale price representing local retail,
wholesale, and shipping costs.

For the entire sales increase resulting from both income and substitution
effects, the weighted average local value-added share is 58 percent
of total sales revenues, of which locally made apparel goods contribute
about 9 percent. As shown in lines 4-8 of Figure 1, the local
value added shares of new sales add up to approximately $133 million
in 1998, $235 million in 1999, and $250 million in 2001.

The 1995 multipliers for the retail, wholesale, transportation,
and locally produced apparel components of apparel sales are shown
on lines 10-14 in Figure 1. Applying these multipliers to the
respective local output shares of new sales, the total
private output increase in New York City would be approximately
$220 million in 1998, $390 million in 1999, and $414 million by
2001 (Figure 1, line 14).

City Tax Cut Impact on Revenues

IBO's estimate of the impact of increased economic output on City
revenues is based on forecasts of overall City tax revenues and
changes in revenues relative to Gross City Product (GCP). Gross
City Product is a measure of the total value of goods and services
produced in New York City and is the basis of the transactions,
income, and wealth taxed in New York City. Excluding under-$500
clothing sales taxes, New York City will collect about $5.15 in
taxes for every $100 in Gross City Product (GCP) in 1998.

However, secondary revenue impacts from the sales tax cut would
initially be smaller relative to new output, with new revenues
rising from $3.30 per $100 added output in 1998 to $4.10 in 2001.
Secondary revenue impacts would be relatively small in the short
run because, as noted above, there are lags between changes in
economic output and corresponding changes in tax collections.

The lags between expansion of output and growth in tax collections
would be shortest in the case of transaction taxes (sales and
excise taxes) and longest in the case of wealth-related taxes
(real property taxes). In the latter case, rise in calendar year
1998 market values would be reflected in the January 1999 assessment
roll which would, in turn, not begin to impact billable values
and actual collections until fiscal year 2000. However, only a
small fraction of the impact of the calendar 1998 market value
increase would actually be felt in fiscal year 2000 because over
two-thirds of all taxable assessed value changes are subject to
a five-year phase-in-and most of the remainder are subject to
caps. Thus even if increases in economic activity in 1998 lead
immediately to increases in real estate market values, a 1998
market value increase would not be fully reflected in property
tax collections until 2004.

a) Assumes City and State government outlays are held harmless as taxes are cut.
b) State sales tax includes Metropolitan Commuter Transportation District surcharge.
Line 9 = line 1 + line 6. Line 10 = line 2 + line 4 + line 7. Line 11 = line 5 + line 8.

Once the increases in property tax collections are fully phased
in, total secondary revenue impacts would actually be 10 percent
larger in proportion to output than overall tax collections. This
is because total GCP includes government sector output (which
is substantially tax-exempt), whereas the local gross product
increases connected with the rise in apparel sales would consist
entirely of private sector output (which is substantially taxable).

As Figure 2 (line 2) shows, all this translates into modest but
significant offsetting secondary revenue increases-$7 million
(4.5 percent of the direct cost of the City sales tax cut) in
1998, $13 million (4.4 percent of the direct City cost) in 1999,
and $17 million (5.6 percent of the direct City cost) in 2001.
In 2005, the offset would rise to $24 million, 6.7 percent of
the projected direct cost of the City sales tax cut.

Impact of State Sales Tax Cut

The previous section looked at the economic and secondary revenue
impact of the City's portion of the clothing tax exemption. The
proposal, however, calls for eliminating all sales taxes
on clothing priced under $500. There would be an additional boost
to the City economy from the accompanying State sales tax exemption.
This would also produce tax revenues for the City, but it is important
not to lump these into the calculation of the secondary offsetting
gains from the City tax cut. To do so would exaggerate
the "dynamic scoring" capacity of City tax reductions.

State tax cut impact on City tax revenues. The analysis
of the impact of the State sales tax exemption largely follows
the analysis of the secondary revenue impact of the City exemption.
The City revenue offsets from the State exemption would be a little
larger than the offsets from the City tax cut itself, since the
combined State and MCTD sales tax rate (4.25 percent) is higher
than the City sales tax rate (4 percent); thus the State/MCTD
exemption would generate slightly more new sales revenue and output
in New York City.

As before, lags between economic expansion and increases in tax
revenues cause City revenue offsets from the State reduction in
sales taxes to increase over time, rising from almost $8 million
(4.8 percent of the direct City cost) in 1998 to $18 million (6.0
percent of the direct cost) in 2001 (Figure 2, line 4). As property
tax revenue impacts are fully phased in, there would be a further
rise in revenue offsets to $25 million in 2005 (7.1 percent of
direct City costs).

Combined City and State tax cut impact on City revenues.
IBO estimates that in 1998 the combined effects of City and State
clothing tax exemptions would increase City sales receipts by
about $477 million, including $145 million shifted mainly from
New Jersey. In 1999, the sales increase would be $844 million,
including $255 million in sales recaptured from New Jersey. By
2001, total sales would be up $896 million, with shifted sales
contributing $271 million.

Given the proportions of local value added in New York City clothing
sales, these sales increases would encompass increases in apparel-related
City output of $274 million in 1998, $486 million in 1999, and
$515 million in 2001. This in turn would yield increases in total
City output in these three years of $455 million, $805 million,
and $853 million.

A comparison of tax cut impact estimates: IBO and EDC

The New York City Economic Development Corporation (EDC) has stated
that new economic activity generated by the clothing tax exemption
would enable the City to recover nearly 40 percent of the direct
costs of the tax cut. IBO's estimates of the impact of eliminating
under-$500 clothing sales taxes on New York City sales, economic
output, and tax revenues are all considerably lower than the estimates
provided by EDC. The sales increase estimates derived from EDC's
model are almost a fifth larger than IBO's (close to $1.1 billion
versus just under $900 million in 2001); the output increase estimates
two-thirds larger ($1.4 billion versus $850 million in 2001);
and EDC's secondary revenue impact estimates are nearly three
times the size of IBO's (38.6 percent of direct costs versus 13.9
percent when revenue impacts are fully phased in).*

EDC's sales impact estimate is larger because their model assumes
a higher percent increase in apparel sales for every 1 percent
reduction in sales tax rates in the City. EDC's 1.7 tax elasticity
is taken from the Washington State Excise Tax Noncompliance
Study. But that estimate was for all retail trade;
when analyzing the effect of sales tax differentials on major
components of retail, the Washington study detected high impacts
for durables and autos but found that "for the case of apparel
sales, however, there is not sufficient statistical evidence that
Washington border counties lose sales to the lower tax states."**
IBO's more conservative assumptions regarding the responsiveness
of sales to changes in clothing tax rates are more in line with
this finding.

In estimating the impact of increased clothing sales on overall
economic activity in the City, EDC uses a smaller multiplier than
IBO, but applies it to the entire change in sales. This exaggerates
the local impact of the sales tax cut because, as noted above,
over two-fifths of the value of apparel sold in the City is non-local
output.

Finally, EDC's estimates of output and tax revenue growth imply
over $8.20 in new City tax revenues for every $100 in new output.
This is far higher than the 1998 City average of $5.15 in tax
revenues for every $100 GCP. After all property tax impacts are
phased in, the tax cut should yield slightly higher than
average tax revenues per $100 new output (since this new output
would be entirely private sector output)-but not more than one
and a half times higher than average. It is not clear how new
economic activity could generate so much more tax revenue than
an equivalent amount of existing economic activity.

* The EDC model is presented in Economic Benefits of Reducing
the Sales Tax on Retail Clothing in New York City (New York
City Economic Development Corporation, January, 1997). That report
estimates the impact of a 4 percent clothing sales tax reduction;
the results have been adjusted to the case of a full 8.25 percent
clothing tax reduction.

Based on these increases in economic output, the total City revenue
offset to the direct cost of the City tax cut-the offset generated
by the City exemption plus the offset generated by the
State exemption (line 2 plus line 4 in Figure 2)-would be $15
million in 1998 (9.3 percent of direct City costs), $26 million
in 1999 (9.1 percent of direct City costs), and $35 million in
2001 (11.6 percent of direct City costs). Net of all revenue offsets,
the clothing sales exemption would cost the City $146 million
in 1998, $259 million in 1999, and $267 million in 2001 (Figure
2, line 5). The total secondary revenue offset would recover $54
million, 13.9 percent of direct City costs, in 2005.

Tax Cut Impact On State Tax Revenues

Just as the City's increased economic activity from both City
and State sales tax cuts would have secondary impacts on City
tax revenues, thereby offsetting direct City tax cut costs, so
it would also have secondary impacts on State revenues,
thereby offsetting direct State tax cut costs. A full analysis
of the fiscal effects of the tax cut should include-but carefully
distinguish between-the impact of City and State tax cuts on both
secondary City tax revenues and secondary State tax revenues.

Lines 6 through 8 of Figure 2 show how the stimulation of the
New York City economy by City and State sales tax cuts would effect
State tax cut costs. Since the State is projected to collect slightly
more revenues per $100 output than the City, the State revenue
offset is proportionally a little larger than the City revenue
offset. Since the State does not have a property tax, the State
offset is also less lagged than the City offset.

Lines 9-11 of figure 2 show the total City and State direct sales
tax exemption costs and offsetting revenue increases in New York
City. By 2001, combined City and State revenue gains would offset
13 percent of combined direct City and State sales tax cut costs
in New York City. After City property tax revenue impacts are
fully phased in, the combined offset would be 14.1 percent of
combined direct costs.

Alternative Scenarios

The Mayor has indicated that New York City will request legislative
authority to go ahead with it's own clothing sales tax cut even
if State sales taxes are not reduced. How this would effect retail
sales and secondary revenue offsets in the City depends on whether
or not other New York localities follow the City's lead and also
cut their own sales taxes on clothing.

All localities cut clothing sales taxes. The impact
on retail sales of a City sales tax cut is slightly smaller when
the State sales tax is not also cut. When only local apparel
sales taxes are reduced, the income and substitution effects from
the City's tax cut would be unchanged, but some of the new spending
on apparel in the City would be absorbed by State sales taxes
on the increase in apparel sales. As a result, the increase in
before-tax sales attributed to the City tax cut (as opposed to
after-tax expenditures) would be not be as large. With a smaller
increase in sales, the City sales tax cut impact on output and
secondary City tax revenues would also be reduced-but only by
a very slight margin.

Only New York City cuts clothing sales taxes. If
other New York localities do not cut their sales taxes on under-$500
clothing, then the City sales tax cut would lead to recaptured
sales from Long Island and the northern metropolitan region counties
as well as from New Jersey. While the spending shift from New
Jersey would result from eliminating sales tax differentials that
serve to the disadvantage of the City, the shift from the surrounding
New York counties would be the result of creating sales tax differentials
favoring the City.

The size of the shift is a function of the impact of reduced New
York City sales tax rates on after-tax price ratios under
the different scenarios. When the before-tax apparel prices in
the region are equal they can be set equal to 1. Then the after-tax
price in the City is 1.0825 (one plus the clothing tax rate in
New York City), the after-tax price in the rest of the metropolitan
region is 1.0335 (one plus the weighted average tax rate in the
rest of the New York-New Jersey region), and the after-tax price
ratio is 1.0825 1.0335 = 1.0474. That is, after-tax apparel
prices are, on average, 4.74 percent higher in New York City than
in the rest of the region.

Figure 3.
Impact of Tax Cuts on Apparel Price Ratios and City Sales
Under Alternative Scenarios

(A)

(B)

(C)

(D)

After-taxprice in NYC

After-taxprice in restof region

After-tax priceratio (A / B)

Percentshift ofsales to City

(1) Current sales taxes

1.0825

1.0335

1.0474

Scenario I

(2) All State and local apparel sales taxes cut

1.0000

1.0000

1.0000

(3) Percent change from current

-7.62%

-3.24%

-4.53%

3.59%

Scenario II

(4) All New York local apparel sales taxes cut

1.0425

1.0171

1.0250

(5) Percent change from current

-3.70%

-1.64%

-2.14%

1.70%

Scenario III

(6) Only New York City apparel sales taxes cut

1.0425

1.0335

1.0087

(7) Percent change from current

-3.70%

-0.00%

-3.70%

2.93%

Source:

Independent Budget Office

Note:

a) Rest of region includes Long Island, metropolitan counties north of New York City, and northeast New Jersey.

Figure 3 illustrates the impact of alternative sales tax cuts
on the price ratio and on New York City retail sales. Current
after-tax prices in the metropolitan region and the price ratio
are shown on line 1. Under the basic scenario in which all New
York under-$500 clothing taxes are reduced to zero (Scenario I),
the average price of clothing falls 7.6 percent in New York City
(line 3, column A) and 3.2 percent in the rest of the metropolitan
region (line 3, column B). This reduces the price ratio
by 4.5 percent (line 3, column C), and on the assumption
that this closes the City's retail gap with New Jersey, this corresponds
to a 3.6 percent shift in apparel sales into New York City (line
3, column D).

When local sales taxes are cut statewide (Scenario II), a 4 percentage
point New York City rate reduction is accompanied by a 2.1 percent
decline in the apparel price ratio (line 5). Given the relationship
between the change in the price ratio and the shift in sales assumed
in the first scenario, the 2.1 percent drop in the ratio yields
a 1.7 percent rise in retail sales (plus some additional spending
absorbed by State taxes). This again consists mainly of sales
recaptured from New Jersey.

When only the New York City sales tax is cut (Scenario III), the
4 percentage point reduction in the tax rate on under-$500 clothing
sales now yields a 3.7 percent decline in the apparel price ratio
(line 7). In line with our previous results, the 3.7 percent decline
in the ratio corresponds to a 2.9 percent shift in City retail
sales (again net of State taxes). The much greater sales shift
in the third scenario as compared with the second reflects the
additional spending that the City would capture from the metropolitan
New York counties if they do not also cut their clothing sales
taxes.

The key to this result is the fact that when only the City sales
tax is cut, the percent reduction in the price ratio is as large
as the percent reduction in the City price itself, whereas when
all New York sales taxes are cut, or when local taxes are cut,
the price ratio reduction is less than three-fifths as large as
the City price reduction. Thus the impact of the City's tax reduction
on relative apparel retail costs is significantly stronger when
sales taxes are not cut elsewhere. The resulting rise in City
retail sales would be $268 million in 1998 (including $113 million
shifted from the New York and New Jersey metropolitan region counties),
$474 million in 1999 (including $201 million shifted), and $503
million in 2001 (including $213 million shifted).

The accompanying secondary increases in City revenues would be
$8 million (a 5.1 percent offset of the direct cost of the cut)
in 1998, $14 million (5.0 percent) in 1999, and $19 million (6.4
percent) in 2001. By 2005, $27 million in fully-phased in secondary
offsets would recover 7.6 percent of the direct City cost. Thus,
leaving the State's clothing tax in place, the impact of the City
clothing tax cut would be boosted by almost a fifth if other New
York localities refused to cut their own clothing sales taxes.

Phased-in tax reductions. The State Senate has passed
a bill (S.B. 2) including an alternative clothing sales tax cut
proposal. Here, State and local sales taxes on under-$500 apparel
would be phased out over four years. Incremental one percentage
point reductions in the State tax (and proportionate reductions
in local taxes) would start on June 1, 1998, and taxes on under-$500
apparel would reach zero on June 1, 2001. Thus, the first fiscal
year in which under-$500 apparel would be fully tax exempt would
be 2002. Under this scheme, the direct City sales tax cost would
be $14 million in 1998, $86 million in 1999, $162 million in 2000,
and $242 million in 2001. After 2001, the direct costs would be
the same as under the proposal in the City's adopted budget.

Secondary City revenue offsets-from both City and State sales
tax reductions-would be a little over $1 million in 1998, and
rise to $23 million (9.7 percent of the direct cost) in 2001.
By 2005, secondary revenue offsets would reach $45 million (12.8
percent of the direct City cost), which would be about $4 million
less than under the Mayor's proposal. Given the phase-in of the
tax reductions and the lagged response of property tax revenues
to output increases, it would take until 2009 for the secondary
revenue offsets under the Senate bill to reach the same level
as under the City's proposal.

Conclusion

The above analysis shows that eliminating sales taxes on apparel
priced under-$500 would increase New York City sales and economic
output. The higher output would result in increases in other City
tax revenues, although the full impact of these secondary tax
effects would not be felt until 2005. Assuming that all taxes
on under-$500 apparel are eliminated statewide, the full secondary
tax revenue impacts from eliminating the City sales tax would
offset about 6.7 percent of the direct cost of the tax cut. Secondary
City revenue impacts from eliminating the State sales tax would
offset another 7.1 percent of the direct cost of the City tax
cut, for a total offset of nearly 14 percent.

In contrast, were New York City alone to eliminate its sales tax
on under-$500 apparel, the secondary revenue impacts would offset
7.3 percent of the direct City cost. The higher impact of the
City cut would result from apparel sales shifting to New York
City from Long Island and upstate New York.

An important caution must be attached to all these results, however.
The above analysis abstracts from any impact that sales tax cuts
might have on the outlay side of State and City budgets. This
might be justified for 1998, when the impact of the tax cut on
the City's expenditure budget would be mitigated by the year-end
budget surplus being rolled over from 1997. In subsequent years,
however, tax cuts contribute to already large projected City budget
deficits and increase the size of required gap-closing spending
reductions.

Spending reductions mean less money paid to households from government
payrolls, transfers, or purchases of goods and services. Thus,
while a community's real disposable income is increased by cutting
sales taxes, it is reduced by cutting government spending. Insofar
as sales tax cuts required corresponding reductions in government
outlays in New York City, we would have to assume much larger
substitution effects-much larger sales shifts in response to the
reduction in the tax differential between New York and New Jersey-to
continue to obtain secondary revenue offsets as large as the ones
we have estimated here.

Care must also be taken not to assume that the relatively modest
economic stimulus and secondary revenue offsets projected here
for the clothing tax reduction would apply to other tax cuts.
The secondary impacts of the clothing sales tax cut are relatively
modest because retail expansion is constrained by regional demand
and because much of the additional output sold by City retailers
after the tax cut is imported from outside the City rather than
produced locally. Cuts in other City or State taxes could produce
proportionately larger secondary fiscal impacts by generating
greater increases in local value added.

Finally, although the clothing tax cut is not projected to pay
for itself, it is important to emphasize that it may be desirable
on other grounds, even when impacts on government outlays are
considered. Other important benefits of the proposed tax cut include
increasing tax equity and stimulating growth in jobs, both of
which would especially aid lower-income New Yorkers. By providing
an independent estimate of the fiscal impact of the proposed tax
cut, IBO hopes to provide policy makers and the general public
with the data required to make an informed decision.